It is critical to have an accurate calculation of your taxable income when it comes time to file your taxes with the Internal Revenue Service. Whether you are a business or an individual, you will have taxable income show up on your return. Understanding what taxable income is, what makes up the number, is important.
What Is Taxable Income?
Taxable income is income from a variety of sources whether you are an individual or a business. Taxable income is going to start with any wages you may earn, inclusive of salaries and bonuses. If you work full-time and are on salary, plus get a bonus annually, those two numbers are going to contribute to your taxable income. Another form of wages would be tips, which also would add up to the taxable income number.
Investment income is something else to consider, as well a variety of other types known as unearned income. Investment income could come from the buying and selling of stocks, as well as through interest income. For unearned income, these income types include things such as child support payments, alimony payments, etc.
Is Any Income Not Taxable?
Could there be a situation where you have income, but it does not contribute to your taxable income number? There are certain types of income that are not taxable. A perfect example of income that is nontaxable would be a payment you receive for a life insurance policy. Another example would be an individual that works for a religious organization but turns the earnings over to that organization at the end of each year.
Calculating Taxable Income for Individuals1. Start With the Filing Status
When you want to calculate your taxable income as an individual, you need to begin with your filing status. This could be single, head of household, or married filing jointly. There may also be scenarios where married filing separately makes more sense as well.2. Go Through the Documentation Exercise
The Internal Revenue Service knows how much you have made due to form filings such as a W-2, 1099, etc. The reality, though, is you still have to gather up all these documents on your own to file your taxes. You need to gather things such as your W2 statement, your interest income statements, brokerage statements, etc. Anything, where you had income-earning throughout the course of the year, needs to be put together. This is all integral to getting to your taxable income number.3. Above the Line and Below the Line Deductions
Once you have your income together, you begin to deduct above the line or above your adjusted gross income (AGI) number and below the line deductions. Deductions above the line would include contributions to an individual retirement account (IRA), while below the line deductions would be home mortgage interest or the standard deduction.4. Getting to the Taxable Income Number
Now that you have your total income, the above-the-line deductions, and below-the-line deductions, you can get to your taxable income number. With your adjusted gross income (AGI), you will then back out your deductions from that number. In simplest terms, this would be your AGI, followed by the subtraction of the standard deduction if you did not itemize, to get you to your taxable income.
Calculating Taxable Income for Businesses1. Figuring Out the Total Revenue
The first step in calculating taxable income for a business is to come up with the revenue that the business made throughout the year. It is important to know whether you are using a cash-basis or an accrual-basis accounting method, as this will impact when the revenue gets recognition from the Internal Revenue Service. If cash basis, you base the number on what revenue hit your bank account in that year. Accrual basis would have you recognize revenue even if some may still be owed to you by a customer, such as a service you sold today, but won’t be paid back in full by a customer until next year.2. Backing out the Expenses
The second step to get to your taxable income for your business is to back out your expenses. Business expenses need subtraction from your revenue to come out to your business income.3. Deductions Reduce the Business Income
With your business income, which is the equivalent of your adjusted gross income for individuals, you are then going to take out deductions that you may have as a business. These deductions, once taken away, will get you to your business taxable income.
The more you understand your taxable income and what contributes to it, the better you can plan for taxes in the present and the future. The concept is somewhat simplistic, but the application and calculation of it can grow in complexity based on your job and/or business.
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Constantly worrying about accuracy when it comes to tax time is not another concern you need. The team at Chandler & Knowles offers both tax preparation and tax planning services for both your individual and business needs. If you're searching for a solid and dependable CPA partner, contact our team today.